April 25, 2012; Dire Expectations for Late 2012

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

 

Kevin:  David, today the topic is expectations.  We were talking to a friend of yours the other day about the book, Great Expectations, and some of the insights that Dickens had in that book.  As we talked last night, we were starting to look at expectations in the marketplace and we were looking at expectations of things as random as farm-fed fish instead of salmon swimming upstream.  Tell me about expectations.

 

David:  Kevin, we will talk about a couple of things today, general market observations, for one, some observations in the gold market, and as random as it may seem, there is an interesting new movie out called Salmon Fishing in Yemen.  We would argue that there is a Dickensian twist in it, so we will tie that together as we go on.

 

Kevin:  Are you headed to the desert to go fishing anytime soon?

 

David:  Not any time soon, but it was an interesting story.

Kevin:
 We have global markets seeking an impetus to move higher, and frankly, not finding one.  Here in the U.S. we have the first quarter earnings from a variety of U.S. companies, and although they are beating expectations, they are falling short of being inspired.

 

Kevin:  And that is the word that we are bringing into this program today – expectations.  I run a 13-minute mile, David, and that is not impressive.

 

David:  Did you say run?

 

Kevin:  (laughter) I’ve got a dog that is 11 years old, and a little overweight, so we run very, very slow.  But if I run a 12-minute mile, that is still hardly anything to write home about, but its beating expectations.  It’s better than a 13-minute mile.  These expectations that are being put out for these companies are actually relatively low, and they are not signaling recovery, but if you can beat it by a penny or two, by golly, it makes for good TV.

 

David:  Speaking of TV, this last week on CNBC, one of the questions was relating to Freeport-McMoRan.  We discussed it in depth with Brian and Kelly, and the issue was that they beat expectations by 11 cents.  They were supposed to earn 85 cents, and they earned 96 cents.  Wasn’t this great news?

 

The problem was, really, if you looked at last year’s performance, they earned 764 million this year, which is great, but last year they earned 1.5 billion.  This is three years of a declining trend, and although the Grasberg Mine was closed for three weeks, you have to look at it in the larger context and say, “Wait a minute.  Three years, yes, that maybe a trend does make, as opposed to three weeks, or three months, or what have you.”  Yes, the number beat expectations by 11 cents, but they have some significant issues.

 

Kevin:  Dave, I saw the interview, and yes, it is like popping their bubble.  There is a difference between you and I getting to talk about what we think is the reality of the market without feeling like we have to keep people upbeat and the heartbeat high and all the excitement of financial TV, but when you fly out to New York, they have certain expectations, as well.  The expectation is that you are going to say, “Hey, they beat expectations by a couple of pennies.  That’s good news.”  And it wasn’t.  And I saw their faces.  They were trying to turn it around from that point forward.

 

David:  No, and in fact, I don’t know if I should even say this, but I did get a series of e-mails saying that I was not allowed to talk about the initial jobless claims.  And then it was followed up with another e-mail saying, “Do not discuss initial jobless claims.”

 

Kevin:  Don’t discourage the audience.

 

David:  You shall not.  It was almost like a royal “Thus spakest the media.”  But it was interesting, a good interview.  The issue, Kevin:, is that we have jitters in Europe that are not surprising, yes, they are back, but what is surprising is that we thought it would be perhaps a little bit further out on the time horizon.  The long-term refinance operation which we have talked about started in December, and then the second followup in February, that was designed to relieve credit stress, at least until the fall of 2012, at the earliest, and 2015 for a good number of loans, even buying more time.

 

Kevin:  And ala the Federal Reserve here in America, the ECB is already suggesting alternatives, to monetize rather than refinance.

 

David:  Right.  The LTRO is not sufficient.  They are finding that they actually have to monetize.  The ECB is back to that gambit and the Fed is, as well.  Two weeks ago, more than 10 billion, last week more than 23 billion, in treasuries that were monetized.  We are seeing some root rot in the credit markets, and it is faster than we would have assumed, given the amounts of money that have been made available to the credit markets to stem the tide of concern.

 

Kevin:  Looking further down the horizon is the IMF.  They are already raising funds for the next crisis.

 

David:  Right, Kevin:, but even though this looks like the Battle Royale and the remake overseas in the European credit markets, we will have our own version of that in the next 12-24 months in the U.S.  The U.S. is having to defend the treasury market, and having to suppress interest rates, to gain an advantage in the credit market.

 

You can’t carry 15 trillion dollars in debt.  Now, the estimates are, by Labor Day, to have over 16.6 trillion dollars in debt.  You can’t carry that kind of debt load without being concerned about the interest component, and you have to keep it low in order to keep it affordable.  There’s a lot at stake, and over the next 12-24 months we are going to get to see just how willing they are, and what tools they are willing to use, to defend this position.
Kevin:  The IMF is recognizing this at this point.  They are starting to raise funds for a crisis that they say may be coming down the road.

 

David:  The next global credit crisis, which they assume is sooner, rather than later.  This is likely because they recognize European bank capitalization requirements are in the process of having to be met.  There is a need to get capitalization ratios to higher levels.  In other words, there is a need to have more liquid capital available at each bank, and what that really entails is that they have to sell off assets.  This is remarkable.  If you remember, these are very, very highly leveraged balance sheets at these individual financial institutions, and they own a bunch of stuff, but have borrowed money to buy it.

 

You generally think of what you have in your own personal portfolio, and you think, “Well, I own it.”  But if you use margin to buy a little bit more than you could afford, now you are sort of increasing your risk component, and you could end up with a margin call if something happens.  Well, they have blown out the concept of a margin call, and once they achieve these new capitalization ratios of 7%, that will bring them down to a “conservative” portfolio of 14 times leverage – 14 times leverage.

 

Kevin:  What you are saying is that it is like a $140,000 investment, with $10,000 down.

 

David:  That’s not exactly a conservative way to run a bank, but that is the European version of getting more conservative.  We have better capitalization rates in the United States at our big banks, but we have been seeing them move a lot of their loan loss reserves into earnings.  In fact, we were talking about Freeport McMoRan earlier, Morgan Stanley and Bank of America both did that – multi-billion dollar moves from loan loss reserves over to earnings, and they beat their numbers, but was it from organic growth?  Was it from expanding their loan portfolios?

 

Chinese growth is slowing.  That is another component in this general market segment.  Yes, it is growing, and the argument is, “8.1% is a heck of a lot better than U.S. growth.  What are you complaining about?”  It is the trend that we see, and it is really a trend toward reconstructing their entire economy, which requires, partially by design, partially not, a slowing of growth as they re-orient, as they re-tool, toward a different kind of growth.  That, again, is in complement with Europe and the U.S. tightening their consumptive habits.  If it wasn’t by choice and by design, they would have to make these changes, because it isn’t like they can be the exporting giant they were, feeding a limitless appetite in Europe and the U.S.

 

Kevin:  David, I think we should probably point out, shifting gears here, that looking at the markets over the last six months or so, you brought up the word grind the other day.  It seems like just sort of a grind.  Europe is not quite a crisis, completely falling apart.  China is still growing, but it is shrinking in its growth.  Earnings expectations are above normal, but they are still in recession or depressionary kinds of moves.

 

I will give you the example of gold.  We sent our clients, a few months ago, a picture of the 65-week moving average of gold, which for the last 10-11 years has just been steadily rising.  It is a nice incline.  If you look at the average price, averaged over the last 65 weeks, it has continued to rise.  But here is the crazy thing.  If you watch daytime financial TV and are completely fixated on the price, what you are going to see is that gold went from $1900 over the last six months down to the mid $1600s, yet the moving average moved from $1300 to $1600.  So the long-term market is coming up and meeting it, and the expectation is that that will continue.  The problem is, short-term thinkers right now are just looking at the last quarter.

 

David:  And what they may not realize is that they are subject to influence, and whatever their information source is, they are either going to be thinking in terms of long-term, or short-term.  So, if you do have a nanosecond judgment, be aware that it may be sort of contemporary media that has shrunk your sense of time, and really, forced an important decision into an irrelevant sense of time.  You need to be looking at the longer-term issues, and that is where I think we see the major trends playing out.

 

A few weeks ago I was at a meeting in New York, and Stanley Druckenmiller spoke, one of the greatest traders of our generation.  One of the first things he said was that the bear market in equities that began in 2000 has yet to end.  That is how he began his comments.  Yes, we are in a bear market in equities.  And yet, you wouldn’t hear that.  The context is so truncated, we think of these little miniature cycles, whether it is this week, this month, this quarter, and not in terms of the major trends in the market.

 

We have had a breakdown in the credit markets and there has been no fuel to take equities to new and higher levels.  We have been through this almost 12-year process of a sideways grind, very much like that period of 1966 to 1982.  We went nowhere quickly during that same period of time.  Meanwhile, as we got toward the end of that cycle, inflation began to pick up.  We will see that, I think, in this cycle, too, and that was not only the concern of Druckenmiller, but a lot of folks who were at this conference.  But it was interesting, because here is a trader who does think in short-term snippets, but he is willing to acknowledge that we have a large context here, and that larger context is a bear in equities.  Incidentally, one of the things he was bullish on was gold, but that is maybe for the next part of the conversation.

 

Kevin:  In the 1966-1982 period, I think we need to point out that gold rose 30-fold versus equities at that time.  That was an amazing reversal, but very few people actually recognized it.

 

David:  And it was incredibly volatile, but what we would point out is that the trend was not volatile.  The trend was generally up.  It was intact.  It moved up over a 10, 12, 15-year period.  It didn’t get to where it finally went in a day.  If there is a destination out there, we need to realize that there is a bit of a journey in the process of getting to the destination, and I think what you see as a reminder, as a signpost, that you are on the right track, is that 65-week moving average.  As you mentioned, it has gone from 1300 up to about 1650, which is amazing.  The trend is slow-moving, but powerful.

 

It is often the daily movements in the market that obscure the long-term trend.  If you are following a major consolidation, and we are in a major consolidation, which is to say, a move sideways, or a move down, in price, the next move is higher.  And it doesn’t have to be gold, but if you are looking at these periods of consolidation in any investment, that is generally the next direction.  The price has moved down now to the 65-week moving average, it has done this repeatedly over the last ten years, where support was strong there at the 65-week moving average.

 

Kevin:  And that was typically the lowest you could buy that before it moved on up to a new level.

 

David:  Now, there was an exception to that, in 2008, when there was a very short-lived decline, and full recovery, to even higher prices, and that full recovery and decline took less than 90 days.  So the worst-case scenario, the catastrophic event, in the de-leveraging of the world as we knew it, meant that gold took a side-step for a three-month period, and was right back on track.  Whoa.

 

Kevin:  Talk about whoa, David, in the 1990s there was another trend that was amazing to watch.  The large central banks in Europe just continued to sell gold.  We used to have a joke.  In fact, one of the guys on our old monitor that told us the gold price, had a button that he had created that said, “Press once gold hits $290,” so just as soon as gold got close to $300, we would press the button and then it would drop down to $270.  It did this for years, and a lot of that was central bank selling into the market, and Brown was reknowned for that with the Bank of England.

 

David:  Not the only Gordon that comes from England.

 

Kevin:  But there is a trend change in that, too.  I think we have to look at the trend change in the fact that central banks are not net sellers right now.  They are net buyers of gold, are they not?

 

David:  They are.  Estimated to grow to 800-1000 tons by 2013, up from basically zero in 2007.  You were talking about a previous era where they were actually liquidators into the market.  Kevin:, this is largely new currency reserves which have amassed over the last 20-40 years by developing countries.  It is in sync with the theme of the rise of the rest.  As the G3 has become less relevant and the audience has expanded to the G7, and the G7 has then become less relevant, and the G20 has become more relevant.  We are seeing a sort of democratization within the world where everybody wants a larger voice, and is not willing to just follow the lead of what once was two great powers, and is now one great power, the United States.  Everyone feels that they should be represented, and represented well, and they will do that best representing themselves.

 

Kevin:  It is amazing to see some of these countries we didn’t even think about ten years ago, exerting influence, but even beyond influence, they want actual say in worldwide monetary affairs.

 

David:  We even see evidence for that in the last round of fund-raising at the IMF.  They raised several hundred billion dollars.  The U.S. did not contribute, but everyone who did contribute said, “Okay, now the IMF has a bigger war chest.  We have given you the war chest, and we expect to have more of a voice.”  There was a sort of a gift with strings attached, but I think that it to be expected.

 

Kevin:  The central banks had always been strong on buying of dollar reserves.  That was sort of written into the contract of the Bretton Woods agreement, which, by the way, we have slowly broken.  But with that being said, do you think that this increase in gold reserves in the central banks is another way of moderating dollar exposure?

 

David:  That is exactly what they are doing.  Implicit in this is the challenge to the singular nature of the dollar reserve status.  In large part, the purchasing of gold by the central banks is exactly what you described.  It is a moderation of existing dollar exposure.  We see it with Mexico.  We see it with Russia.  Just here in the last day, there was announced an additional billion-dollar purchase from both Mexico and Russia.  We have Thailand, Korea, Bolivia, Columbia – countries like this that have benefited from trade with the U.S. and Europe, and they want to solidify their capital base.  These are the types of countries that are utilizing trade surplus dollars for gold acquisitions, which is very different than the old gold-holders.

 

Kevin:  Right.  Looking at the gold reserves, the United States still leads the pack as far as gold reserves.  At least that is what they say – 8000 tons of gold.  There are people out there who say we don’t even have that, but I’m not going to go down that road.  What are the countries that play the largest role in gold reserves right now?

 

David:  There are two different worlds, Kevin: – pre-Bretton Woods, and post-Bretton Woods.  The pre-Bretton Woods folks are the old guys who still have the gold – the U.S. with over 8000 tons, Germany with between 3000 and 3500 tons of gold, the IMF with close to 2900 tons, Italy with about 2400-2500 tons, France, I think, at right about the same.  Then we have the new crowd, of the post-Bretton Woods era.  Those are the folks who have developed these capital bases, these asset reserve bases, as a result of selling stuff.

 

Kevin:  Are you talking about China?

 

David:  China, the Middle East, but Asia, specifically, because they are the ones who have been manufacturing and selling into our voracious appetite to consume more and more stuff.  China is choosing to acquire ounces on the open market.  They are also buying mines instead, and that gives them the ability to build their reserves, in terms of gold ounces, at the cost of production as opposed to the market price.  That saves them anywhere from $600 to $800 per ounce.  It is a little bit funny to me that “you never pay retail” seems to be that sort of ironic principle in play from the country that has supplied, and continues to supply, the retail gluttons all over the world, Wal-Mart being their primary distribution depot.

 

Kevin:  I know that Wal-Mart is sort of a sore subject right now, so we won’t bring up Wal-Mart, but as far as investment demand, we were talking central banking demand, and it is actually more than subtle that China produces more gold than anybody in the world now, over South Africa.  They now import more gold than anybody in the world now, plus they are buying mines.  Not only are they buying gold, but they are buying up that which produces it from the ground, so maybe they will take their 1100 tons or so and turn that into 2000, 3000, 4000 tons pretty quick.

 

David:  And it is unabated demand in Asia, with a slowing trend in the U.S., and for us, this is not really a concern.  U.S. physical demand, if you want a relative comparison, is roughly 2½ times the size of Vietnam.

 

Kevin:  So we don’t represent much.

 

David:  No, not when we are outpacing Vietnam, we are outpacing Turkey, we consume about twice the gold that Turkey does.  If China and India account for 52% of physical gold demand, if you throw in the rest of the Pacific Rim region, it is closer to 60-65%.  The U.S. buys as much in physical metals as the entire Middle East.  Frankly, given the size of our economy, which is significantly larger, that still surprises me.

 

Nevertheless, U.S. demand, we think, will pick up over the next 12-24 months, in a final stage of the bull market in metals, maybe 36-48 months, but it will coincide with the reason for global panic into the metals, and it will be U.S. consumers buying, perhaps for the first time, for the same reason, an even larger audience globally, a U.S. fiscal crisis coinciding with monetary policy excess.

 

Kevin:  This makes me think we may have been asleep at the wheel, Dave.  People have talked about gold being an inflation hedge and just keeping up with inflation, and when gold goes up, it is mainly because of the printing of money and inflation.  Maybe we have been asleep at the wheel.  Maybe gold is rising.

 

Your dad used to talk about the Golden Rule all the time.  The Golden Rule is “He who has the gold makes the rules.”  The gold is being shifted over to the East.  The prices have been rising because of this incredible demand.  How much does it really play into the true CPI numbers?  Is it really being affected by inflation right now, or is it more the demand?

 

David:  We know that central banks are still controlling the most gold in the U.S. and the West, but there is this gradual shift, and I think we can extrapolate and say that over the next several years, should this continue, the 1200 tons per year that the Chinese will not only buy on the open market, but produce, themselves.  Over several years, they will accumulate more than France.  They will have more than Germany, they will be neck and neck with the U.S., number two, in terms of total stock of metals.

 

Kevin:  But on the point of inflation, David, our expectation, going back to that theme of the show – expectations – our expectation is that gold keeps up with inflation.  Is it inflation that is influencing this 11-year bull market?

 

David:  I think, actually, gold does a very poor job of keeping up with inflation.  It does an excellent job of catching up to inflation.  At some point, you do see the rubber band snap, and the gold price does catch up to inflation, and it does reflect inflation.

 

Kevin:  So it returns to an equilibrium, but it doesn’t necessarily keep up with it all the time.

 

David:  That’s correct.  There is the misconception that gold has been moving up over the last ten years in light of U.S. CPI expectations, the Consumer Price Index, and the way we measure inflation here in the United States and that is why gold is moving higher.  If there is no inflation, then gold should go down.  In fact, there is little evidence for this.  Overwhelmingly, the price has been driven by an increase in nominal income growth in China and the Indian subcontinent.

 

That has been the primary driver over the last 20 years, and particularly, the last ten years – more money flowing to the general populations, in countries where gold has been bought for cultural reasons for centuries.  They have more money to spend, and what do they like to spend money on?  What have they liked to spend money on for decades, if not centuries?  And that goes into the social structure of the societies today.  What about slowing growth in China?  That could be an issue.

 

Kevin:  That is what I am wondering.  Does it argue for a decline in prices if they are starting to shrink?  When I say shrink, it is a little bit like saying they are not growing as quickly, because their growth is still outpacing the United States’ growth by at least 7%.

 

David:  I would argue that, quite to the contrary, slowing growth in China comes part and parcel with the rebalancing of China, as they are attempting to take away from export dependence, the economy based on that, and also, move away from government-directed investment schemes.  What they are having to do is create the backdrop for a consumer-oriented economy.  We are seeing that in rising wages.  We are seeing that in the sacking of Bo Xilai and a host of other indicators that show that the politburo is very intent.  Their recent five-year plan stated it explicitly, and they are following through in terms of actions that say, “We are going to make the transition to being less export-dependent, and being more autonomous.”  We are seeing that as they talk about their currency, and seeing it move toward a free-floating economy.  They are expanding the rubber band even further. This is the point.  Households will be positively impacted by this increased income as the government attempts to wean itself from that old mercantilist model of growth and push toward a consumption model of growth.  I am not saying that is the ideal model, that everyone should just buy more stuff, but that is a way that they can wean themselves away from U.S. and European dependence.

 

Kevin:  Stephen Roach has pointed out in the past when we have interviewed him that there is no social net that will catch the retired.  We have social security, we have various entitlement programs and that is a different show altogether, but the Chinese really have nothing there, so they have to save.

 

David:  And I would suggest that if you are looking for something that is gold-negative in the China story, it is simply this, and it is a very, very future tense issue.  As, and when, the politburo begins to effectively implement a social safety net, and people begin to have confidence in that social safety net, it takes some time for people to adopt a different pattern of behavior when it comes to investing and saving.  We are talking about Social Security, the equivalent of MediCare and Medicaid where people know that their retirement needs are going to be met, they know that their health care needs are going to be met.

 

Why is this important?  Because today China has a huge savings rate, and it is not just because they are generally thrifty, it is because they have nothing to count on in the future.  They have to depend on themselves, therefore they save 50% or more of their income.  They don’t have the social safety net.  What government will try to do is ultimately unlock that vast Chinese block of savings by offering some sort of a social plan.  “Here is what we bring to the table.  Here is how we are going to take care of you in old age.  You didn’t have enough children, but that’s okay, we will take care of you.  The state will be your nanny.”

 

Kevin:  In fact, David, if I am thinking right, China actually invented fiat currency.  When we are talking about saving, the question could come up, why wouldn’t you save in dollars right now?  Why wouldn’t you save in euros, or even renminbi?  But they have seen the abuse of fiat currency all through history, and they are buying gold, and they were even encouraged by the state to buy gold.

 

But I am going to shift gears here, because we have talked about demand.  Asian demand, right now, is intact and continuing.  But anybody who takes economics knows that there are not only demand factors, but there are supply factors.  Gold, right now, is much easier, from a monetary standpoint, to mine than it was ten years ago when it was $300-400 an ounce.  Now it is $1600-1700 an ounce.  The profits have to be enough so that they are increasing supply on these mining ventures.  Where does the supply picture come out in this?

 

David:  Let’s say yes, and no, to that comment you just made, because along with the quintupling in the price of gold and silver, there has been a tripling, quadrupling, almost quintupling of the price of oil, if you are talking about the peak in the price of oil.

 

Kevin:  So, the constant mining has gone up, as well, but maybe not as quickly.

 

David:  Right, and that squeezes profits for the miners, but peak production is thought to be reached in the mining space by about 2014 at roughly 3100-3200 tons, and we would estimate that the peak in prices, not the peak in production, would follow the 2014 date, probably 2015-2017 as a time frame.  Of course, events could bring that time frame forward, closer to the 2014-2016 time frame, if the market should become event-driven.  But we don’t have those extra huge mine sources coming onto the market.  We don’t have mine hedging books that are being eliminated.  In fact, there are only about 200 tons that remain, so that is not going to be a major contributor to supply.

 

Kevin:  In other words, gold mines are not like Doritos – “Munch all you want and we’ll make more.”  There is a limit to that, and you are saying 2014 is probably the limit, as far as peak production?

 

David:  Yes, and this is the best that we have, because we have had a huge amount of capital expenditure going into exploration and mine development, and the best we are going to get is about 15-20% increase in mine production, and just for a short little period of time.  That has been growing here in the last year or two, and again, it will peak by about 2014.

 

Kevin:  And I will just add this, David.  Gold, as a percentage of global assets, has shrunk, because global assets have risen.  Let’s just go back to the last bull market in gold, going back to the 1980s.

 

David:  And exclude real estate.  If we are just talking about stocks and bonds, gold represents roughly 5% of total world wealth.

 

Kevin:  So, a nickel on every dollar, basically, is gold.  There is still 95 cents out there that needs to run to something if something gets tense.

 

David:  And if you look at the peak in the 1980s, it was a quite a bit higher number, close to 14% of global assets.  More aggressive estimates at gold’s peak of $875 put it closer to 20% of global assets, and I think that may be stretching it a bit, but 14%, roughly three times relative to stocks and bonds.  It is an interesting story to follow.

 

Kevin:  When we talk about mines hitting peak production by 2014, we have to go back to the 1980s.  It was awfully good to be a gold mining stock toward the end of that cycle.  It wasn’t necessarily good to be a gold share-holder through most of the 1970s, but as that 1979-1980 peak came in gold, you certainly did want to own the mines.  The mines right now don’t seem to be doing very well, at least in the stock market.

 

David:  You have heard of the 80/20 rule. When you are talking about gold versus gold mines, it is more like the 90/10 Rule.  90% of the time you want to own physical metals, and you probably want to own them all the time, but about 10% of the time a very small sliver, a time slice, if you will, and you might be paid handsomely to own the shares.  But again, it’s the 90/10 rule.  You are going to be served the majority of the time best by physical metals.

 

We have had gold stocks which have under-performed the metal since 2006.  Today they are trading at about 30-year lows relative to the metal, and many of them are now in the single-digit PE range, and I think they are likely to trade back to the 30 and 40 price-to-earnings range over the next several years, driven higher by the price of the metal itself.

 

Kevin:  David, we have always warned our clients of this.  Gold stocks are always more risky than owning the physical metal.  You may sometimes have the higher payout, but there are things that can happen.  I have scars on my investment portfolio to say that sometimes a mine will flood, and sometimes a leader will just go ahead and nationalize.  We are seeing this now in Argentina.  We have seen it in Venezuela.  Nationalization is also a vulnerability, isn’t it?

 

David:  We have not only the extreme of nationalization, but we have an increase of royalties and taxes.  Yes, we could even have a confiscation of lease rights in various jurisdictions around the world.  Those kinds of risks abound, and I think we have a conservative set of investors saying, “Well, we kind of like gold shares as a perpetual call, a nonexpiring call on the gold price.”  But with that, you take on a lot of volatility, as evidenced by this last year when we had a little run-up of 11% in gold, and gold shares managed to lose 20% at the same time.

 

Kevin:  Not very impressive.

 

David:  Not really.  But I don’t think that is likely to continue.  I think we will see in this next couple of years an interesting little stretch for the miners.

 

Kevin:  We are not discouraging the ownership of gold stocks, but you have to keep it in perspective, because there is this concept of portable property, or portable wealth.  I remember probably 25 years ago I heard your dad speak, and he was talking about real estate.  He said, “Real estate is a wonderful investment.  God made a certain amount of ground.  If you buy that ground, nobody is going to make more of it.”  But the problem is, you can’t put it in your pocket, you can’t go somewhere else with it, so he always said that it is good to balance your real estate with portable real estate, that which you can put in your pocket, and that is what real gold does.

 

David:  Kevin:, looking at Great Expectations again, Dickens’ famous work, there is this concept of portable property, this much-anticipated coming of age, and the receipt of inheritance.  The interesting part is that a term used to describe it was not, as you may be familiar with, patrimony, or inheritance, or birthright, but it was portable property, because there was a contrast to be made.  When you came of age, there was almost a trust fund, if you will, in modern language, that you got when you were 18 or 21.  But there was also an inheritance that you might have later in life that was not portable property.  These might be estates.  These might be interests in mines.

 

Going back to the theme that you can own the mine, but you can’t really take that with you anywhere, this notion of portable property is what is given to you, literally dropped at your feet, when you are 18 or 21, and that, in the Dickens novel, is what he is given.  What I like about the language is that it communicates very clearly at least one of the benefits of owning that kind of property, whatever it is.  What is your portable property?  Is it gemstones?  Is it gold?  Is it cash?  Is it stock certificates as opposed to something that you don’t have in your physical possession?  What percentage of your wealth is represented by some form of portable property?

 

This is not something we generally think is important in the United States, because why would you need your property to be portable?  This is where I think, in terms of expectations, we deal with a misconception, driven by our history.  We have lived in a very safe continent, surrounded on either side by the Atlantic and the Pacific.  We have never seen the destruction of other real estates, and the idea of having some part of your wealth that is portable just doesn’t even really connect with Americans as much as it does with everyone else in the world.

 

Kevin:  Sometimes you have to travel and talk to people to understand just how good we have had it here in America.  Good or bad, we have really gotten soft.  I was reading this morning before I came in to work a navigator’s tale of the bombing of Cologne.  This was a guy who was a navigator in a bomber in World War II.  They had hit Bremen the week before, they had bombed Cologne.  I know you were in Cologne just a few weeks ago.  These peoples’ towns were completely leveled.  The United States has never experienced anything like that, but in Europe, this is just a continued operation in Europe.

 

David:  Or how about the Middle East?  Or how about anyone who has settled here in the United States from Vietnam?  What did they leave with?  We are talking about gold, or some sort of portable property.  In 1979, when the Russians invaded Afghanistan, there were 747s lined up on runways, and they were loading them with portable property, and I can tell you that it was not Humvees and frivolous things like that.  It was gold bars, headed for a safe jurisdiction, namely Switzerland, or wherever they were most contented holding their gold bars.  That was the only thing that they could take with them, leaving their primary asset behind, the gold that was in the ground, specifically, black gold.  They had to take with them what they could, their portable property.

 

Kevin:  As an American sometimes I realize that I have really lived in an amazingly comfortable environment, a little bit like a farm-fed fish.  When you taste a trout or a salmon that has been raised in a lake and fed a certain amount of food, they don’t taste the same as the ones which have had to move to live, who, as we have talked about before, have had to expend calories to survive.

 

David:  You are talking about farm-raised fish that know where their next meal is coming from.  It is the guy who walks up to them, the natural threat.  Should they flee?  They are prey, he is predator.  Gradually over time this is reversed, and there is a dependent relationship developed, so they know where their next meal comes from, they are unconcerned by predators, they work very little to survive or thrive.  With farm-raised fish the big question is how would these fish adapt to being in the wild?  This is the theme of the movie we mentioned, Salmon Fishing in Yemen.  The challenge was, how do you take 10,000 salmon that have been farm-raised and put them into a stream, when they, for several generations, have never had to swim upstream?  Do they have an instinct, will they survive in nature, having been so coddled and taken care of?

 

Kevin:  Or do they just wait for food and then die?

 

David:  This idea of farm-raised fish being able to adapt – it made me wonder, watching the movie, if we don’t have a generation of investors somewhat like this.  Will they be able to adapt?  We have a generation accustomed to stocks going up, as if the natural current of the market was in one direction only, without the slightest bend in course, or rise or fall over the rocks, being an opportunity.  All they have done is swim in circles, and basically get fed.

 

Kevin:  Not to mention interest rates during the last 30 years.  Our adult lives have been lived with a declining interest rate market.  How hard is it when you can borrow more money at less and less interest?

 

David:  And on top of that, they are now being pressed even lower by artificial means, which, to farm-raised fish may seem normal.  These are the elements, that like nature, have been removed from a controlled environment.  The market is too unruly on its own, the prices are too erratic to move without the external, the superior guidance, of the fish farmer.  We have the Fed as fish farmer, if you will, making sure that the environment is ripe for us to grow and be healthy.

 

I guess the analogy ends, because we don’t end up in cellophane and on ice, but the question is more about adaptation.  Under a different set of circumstances, having been conditioned for generations to believe that the market operates just so, will we adapt to a different set of rules, as, and when, those rules emerge?

 

Kevin:  And those rules are emerging, David, because for the last 70 years we have had a reserve currency.  Not only did the Fed feed us this currency, but it was the world’s reserve currency.  Every time our nation went into debt, they were borrowing their own money.

 

David:  Yes, easy money, and cheaper all the time, a market that allows you to just float about with volatility smoothed by the management of the Fed, and you begin to wonder if this generation of fish can survive off the farm.  I tend to believe that they can, but there is a question of building strength, and coming to a point of stream savviness, if you will, and that is going to take a bit of time.  It is also going to take a recalibration and adjustment to a new and different environment, and a lot of stress and strain in the process.  Survive, we will.  Thrive, I think we can.  The question is, do we have the gumption to transition?

 

Kevin:  I think people who are listening to this show, David, are probably getting a good start, because people who are continually questioning the norm, and saying, “All right, what am I missing?  Where am I too comfortable?  Where do I need to train, or change, what I am doing?”  It is what you have talked about before – rehearsing for something different, and that rehearsal has to be done now, not during that time.

 

David:  It is odd for us in the U.S. to think of portable property, going back to that Dickensian phrase.  It is odd for us to think about even the need for it, because we have had stability – market stability, currency stability, political stability, social stability.  All these things we now take for granted, and the concept of portable property makes no sense to someone who lives in the United States, although for anyone else, anywhere else in the world, it is axiomatic.  You don’t keep all your eggs in one geographic basket.  That, I would suggest, is how we are going to have to begin to think differently, and perhaps, get off the farm.